Wall Street Boosts Borrowers as Real Estate Bond Market Returns
Randy Waesche was running out of time to retire debt he took on to build a Marriott hotel in downtown New Orleans. Then Citigroup Inc. (C) showed up.
Waesche had spent six months seeking a more affordable alternative to terms being offered by his lender, a unit of Capmark Financial Group Inc. Citigroup was able to offer a better rate as the market for bonds tied to commercial mortgages revives following its 2008 collapse. The loan was completed in November, and was part of an $876 million securitized debt sale by Citigroup and Goldman Sachs Group Inc. (GS) in December.
“We went to life insurance companies, we went to everybody,” said Waesche, president of Resource Management Inc., a Metairie, Louisiana-based financial-planning firm, and an investor in several New Orleans-area hotels. “There were very few rocks we didn’t turn over. Wall Street was the only venue available.”
Banks and other firms that bundle mortgages into bonds are lending more money as demand for the securities increases from investors seeking higher yields. That’s making refinancing easier for property owners that have been passed over by institutions that usually hold real estate debt on their books, aiding a recovery in commercial property values.
The rebound in commercial-mortgage backed securities is benefiting borrowers with smaller properties and in areas outside the biggest cities. CMBS issuers fare better in these markets because they can get the higher rates they need to cover the costs of packaging and selling loans. Institutions that keep mortgages on their balance sheets, including insurance companies and non-U.S. banks, focus on top-tier buildings in large metropolitan areas.
“Loans from CMBS lenders are more often on smaller assets or Class B office properties,” said Ben Thypin, an analyst at Real Capital Analytics Inc., a commercial-property research company based in New York. “They haven’t been able to compete that well with insurance companies and international lenders in the office market on the highest-quality buildings.”
About 71 percent of commercial-property lending by insurance companies was done in primary markets in 2010, compared with 67 percent for foreign banks and 47 percent for CMBS lenders, according to Real Capital. About one-third of loans from CMBS firms were in tertiary markets, compared with 6.6 percent for insurance companies and 12 percent for non-U.S. banks, the data show.
‘Good, Stable Properties’
“Just because it’s a secondary or tertiary market doesn’t mean it’s a bad market,” said Mitchell Resnick, co-head of commercial real estate origination and securitization capital markets at Goldman Sachs in New York. “Some of these markets didn’t experience as much of a downturn because they didn’t experience as much of an upturn during the boom years. What people are really looking for is stability. You can find good, stable properties in secondary and tertiary markets.”
Primary markets include metropolitan areas such as New York and San Francisco that are mostly located on the U.S. coasts, while secondary and tertiary markets are comprised of smaller cities and towns.
Citigroup has originated more than $1 billion in CMBS loans over the past six months, about half of which are backed by properties outside major cities, said Marcus Giancaterino, global head of real estate finance at the New York-based bank.
“That is the bread and butter of CMBS,” he said. “The insurance companies have a lot of flexibility on pricing. They select the best. If an insurance company wants a deal, they are going to beat you.”
Sales to Quadruple
Sales of commercial mortgage-backed securities plunged to $11.2 billion in 2008 from a record $230 billion in 2007 when credit markets seized during the financial crisis. Less than $4 billion was sold in 2009, according to data compiled by Bloomberg. Last year, $11.5 billion was sold, and sales may reach $45 billion in 2011, JPMorgan Chase & Co. (JPM) said in a Nov. 24 report.
Wall Street banks were able to land more trophy assets during the real estate boom as sales of commercial-mortgage bonds surged. Still, one of the primary benefits of CMBS is the ability to bundle smaller mortgages and create a diverse investment pool, according to Alan Todd, an analyst at JPMorgan in New York.
“The CMBS market was never solely intended to be the lender to the stars,” he said. “For commercial real estate to fully recover, the CMBS market has to originate loans that insurance companies aren’t vying for.”
CMBS lenders are most competitive on high-profile buildings when the loan is too big to be taken on by a single insurance company, according to Giancaterino of Citigroup. A loan secured by One Bryant Park, home to Bank of America Corp.’s midtown Manhattan offices, was sold in June in a $650 million commercial-mortgage bond deal.
George Yerrall, managing director at RiverOak Investment Corp. in Stamford, Connecticut, needed to refinance debt on six properties leased to Novant Health, a Winston-Salem, North Carolina-based operator of medical facilities. Five of the properties were in Winston-Salem and the sixth was in Loganville, Georgia.
While Novant carries an investment-grade credit rating, insurance companies and commercial banks couldn’t come up with attractive bids because of where the properties are located, according to Yerrall.
“It was all reflected in the price,” he said in an interview. “The tertiary market was more influential than the credit rating.”
Ladder Capital Finance LLC, a New York-based company that makes loans that are packaged into bonds by Wall Street, came up with the only “reasonable offer,” Yerrall said.
Recovering Property Prices
Most traditional insurance companies are focused on cities where property prices are recovering and rents are showing signs of stabilizing, according to Pat Halter, chief executive officer of Principal Real Estate Investors, the fourth-largest U.S. institutional real estate manager.
“In the past year, that’s been mainly in the gateway markets such as New York, D.C., Boston, some parts of Seattle and San Francisco,” Halter said in a telephone interview. Last year was “a story of trying to find high-quality assets in those markets,” he said.
The CMBS originators, while also competing in big cities, are willing to look at a broader base of locations than most major insurance companies, Halter said. In a $2.2 billion sale of commercial-mortgage bonds yesterday by Deutsche Bank AG (DBK) and UBS AG (UBSN), properties span the U.S., from Manhattan and Washington to Knoxville, Tennessee, and Stillwater, Oklahoma, according to documents distributed to investors and reviewed by Bloomberg.
Extra Space Storage Inc. (EXR), a Salt Lake City-based real estate investment trust that operates self-storage centers, used the CMBS market for about 80 percent of its financing until the market froze three years ago, Chief Financial Officer Kent Christensen said. Unable to refinance the debt, the company turned to bank loans, he said.
The company took out an $82 million mortgage from Bank of America last month, the company’s first CMBS loan since February 2007, he said. One of the major advantages in using CMBS debt is that it’s non-recourse, meaning the lender can’t seize the borrower’s assets in the event of default.
“Repayment is subject to the performance of the asset,” Christensen said in an interview. “I like loans that don’t have covenants in them that make it difficult to repay them in a difficult environment, like we had in the past two years.”
Banks, insurance companies and foreign investors are chasing lending assignments across the U.S. amid signs commercial real estate may be recovering. Property values, which have declined 42 percent from 2007 peaks, rose for the third consecutive month in November, Moody’s Investors Service said on Jan. 24.
While late payments on commercial mortgages bundled and sold as bonds increased to 8.8 percent in December from 4.9 percent a year earlier, the pace of rising delinquencies is slowing, according to Moody’s.
Still, many borrowers will have difficulty coming up with the additional cash to pay off debt that exceeds the current value of the property. Additionally, occupancies and rents have yet to recover in many areas, said Halter of Principal Real Estate, based in Des Moines, Iowa.
“It is a good time to be thinking about lending,” he said. “You have to be prudent and you have to be careful about the risk you take.”
Some of the CMBS lending in smaller cities is by new entrants, primarily non-bank finance companies that contribute loans for Wall Street to pool for sale, said Jonathan Pollack, head of commercial real estate capital markets at Deutsche Bank. The Frankfurt-based company’s CMBS lending is concentrated in major metropolitan areas and on the coasts. As the market evolves, the bank plans to expand its reach, he said.
“Sooner rather than later, we intend to be more regionally focused,” Pollack said. “When you look within these markets, there are clear winners and losers. Things are happening within those markets that create lending opportunities.”
Loans being written for sale as securities today are conservative compared with those done when sales peaked in 2006 and 2007, when borrowers were allowed to take on more debt with the assumption that rising rents would cover future payments, said Frank Innaurato, a managing director at Horsham, Pennsylvania-based credit-rating company Realpoint LLC.
As competition among lenders increases, investors need to be on the lookout for the excesses found in loans made during the boom, Innaurato said.
Borrowers are benefiting as investors drive CMBS prices up, with some top-ranked bonds trading for as much as 108 cents on the dollar, according to JPMorgan data. Higher bond prices translate to lower rates on new loans.
“Today, we have about 60 percent CMBS and 40 percent other debt,” said Christensen of Extra Space Storage. “I think we will be above 60 percent CMBS again, but not above 80 percent. After seeing the CMBS market go away, we don’t want to be as dependent on it as we were.”
Waesche, who opened his Marriott five weeks before Hurricane Katrina hit in 2005, was able to extend the construction loan from Capmark for five years in the wake of the storm. Capmark, which filed for bankruptcy in 2009, would have extended the loan again -- an expensive, short-term fix, Waesche said. Thomas Fairfield, a Capmark representative, didn’t return a phone call seeking comment.
While financing for hotels has become easier to obtain in the past three months, they remain the toughest type of property to borrow against, Waesche said. Had Citigroup not come through with a loan, he would have taken Capmark’s terms, he said.
“We would have cried every month when we saw all our earnings go out the door to pay the mortgage,” Waesche said.
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